What Is a Robo Advisor? Everything You Should Know About Robo Advisors (Definition)

What Is a Robo Advisor? — Robo Advisor Definition

Robo advisor firms have seen significant growth since 2014, according to Deloitte. In just eight months, robo advisor firms have increased by 65% from $11.5 billion to $19 billion. But, what is a robo advisor? A robo advisor is an online, virtual service that uses specialized software to help you manage your finances or investments. Robo advisors ask the customer a few questions based on what risks they are willing to take and then distribute the money appropriately based on algorithms.

Robo advisors use the same tools and techniques as traditional advisors but do not normally deal with taxes or other personal aspects of financial management. There are significant differences between robo advisor services and human financial advisors. These differences lie within the cost of the service, the custody of the money, the type of account, the investment being made, tax services and the stocks you are allowed to invest in.

What Is a Robo Advisor, and What Is a Human Financial Planner?

The key difference between human and robo advisor services is that human wealth managers tailor service to a client’s specific situation. Robo advisors ask the customer to complete a questionnaire and assign a portfolio model. With a robo finance service, the investment plan is based on the risk the customer is willing to take. On the other hand, a human financial advisor will personalize every decision to suit your personal needs.

Aside from the personal wealth management services, robo advisors use the same software with their clients. You may be wondering, “What is a robo advisor basing its services on?” Robo advisors base their services on the risks the customers are willing to make.

Secondly, communication with a robo advisor is very different from communicating with a human financial advisor. Robo adviser communications are limited to telephone calls, Skype, and email. Unlike with robo finance, a human advisor offers unlimited communication platforms, including face-to-face conversations.

Thirdly, robo advisors and human financial advisors vary according to the services they offer. A robo advisor focuses on making investments for a client based on their preferred risk factors. Wealth managers take their services a step further by offering not only investment advice but more personal aspects of wealth management, such as advice on taxes, retirement and estate planning. Unlike robo advisors, human financial advisors also do a lot of planning and offer insurance advice.

Asset management between robo advisor and human wealth management services differ. A robo advisor service is passive. This means that robo finance is limited to passive investment processes and management. This may sound negative; however, this allows robo advisors to further minimize expenses for clients. Unlike robo advisors, wealth managers can tailor their management services to their clients’ needs.

Last but not least, robo advisor services are, on the whole, a lot cheaper. The automated services and lack of human contact that robo advisors offer means the services are more affordable than financial advisors. Wealth managers cost significantly more as the services are personalized to customers’ needs.

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What Is a Robo Advisor? — The Advantages

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Over the past few years, robo advisor startups such as Betterment and Wealthfront have made more than $53 billion. Although there has been talk of limitations within the robo finance industry, new federal regulations in the U.S. mean more customers will be opting for lower cost investments with robo advisors. Although robo advisors are still a small portion of the investment and wealth management world, they are expected to grow to $285 billion by 2017. The million dollar question is: what is a robo advisor offering that a human finance advisor aren’t?

Robo advisors offer Lower fees

According to Business Insider UK, “In its Financial Advice Market Review (FAMR), published on Monday, the FCA says that up to 16 million people could be trapped in a ‘financial advice gap’ – they need advice but can’t afford it.” Luckily for them, on average, robo advisors charge approximately half the amount financial advisors do. Before the appearance of robo advisors, customers were deemed lucky if they received assistance on their investment for less than 1 or 2% of the value of their portfolio.

Robo advisors mainly invest in ETFs (Exchange Traded Funds). These robo finance services normally charge a fraction of that 1%, often cutting yearly fees in half. You may also find that these management charges counteract, as robo investors often negotiate fees and/or offer investors free trading.

Customers have 24/7 access

If you opt for a human financial advisor, you are automatically limiting the access to your source of advice. Robo advisor services work entirely online and therefore never sleep. Customers can access everything they need online. Robo advisors are there 24/7 to answer calls and messages on Skype, phone lines, and via email. Robo advisors often include the opportunity to sign up, deposit money, check balances, or even withdraw money at any time.

No need for human contact or meetings at specific locations and times

Dealing with a human advisor face-to-face can be daunting and slightly intimidating. New investors often feel more confident talking on the phone or via email with a robo advisor. Not only this, robo finance is perfect for those who cannot attend meetings due to time constraints, lack of transport, or any other personal reason.

Appealing to younger investors

It is no real surprise that millennials would prefer to invest with robo advisers, as their fees are lower. According to a report entitled “Hype vs. Reality: The Coming Waves of ‘Rbo’ Adoption” by ATKearney, robo advisor services are likely to be adopted by a combination of younger people and retirees. In addition to this, the report states that the majority of consumers consider robo advisors’ low fees to be a critical element for choosing these types of services.

Use of evolving technology offering new services

We live in a world where technology is evolving every day. According to Lexology, “Cognitive computing, big data and gamification are coming… and will revolutionize current models” of robo advisor services. There are a number of applications and games that are in the process of being developed to make using robo finance just a little bit more enjoyable.

Robo advisors are growing the financial advice market

Many young people feel financial advice is out of their reach. Robo advisors make this possible thanks to low fees and ease of access. Thanks to robo advisor services, the financial advice market is expected to grow significantly.

Low minimum balances

Another common reason people do not seek professional financial advice is because of the minimum balance required to get started. Robo finance does not require a huge initial investment. For example, robo advisors like Betterment offer options where the minimum investment is as little as $100.

What Is a Robo Advisor? – The Disadvantages

Robo advisors lack emotion and compassion

If you are hoping to build a relationship with your robo advisor, think again! The lack of emotion or compassion from robo advisors is a factor that can put people off, especially during a financial crisis. Robo advisors are a popular option among young investors; however, retirees may find a tweet or email a very hard way to communicate when it comes to the money they have invested, which in turns pays for their living expenses.

There are sometimes flaws in robo advisors financial theories

As mentioned above, robo advisors base investment plans on a questionnaire which establishes the investor’s preferred risk. To do this, robo advisors use modern portfolio theory to maximize a person’s return on investment. Unfortunately, the methods robo advisors use have been known to have flaws.

The definition of risk that certain robo investors use can be oversimplified. Some investors prefer private rather than public equity, which is not always correct; they often choose this because they believe it is low risk, but actually, private equity could be a risky choice, like if the company is going bankrupt and is in lots of debt.

A robo advisor cannot get to know you and will not personalize your investment portfolio

If you need some hand holding, a robo advisor may be the wrong option for you. When using a robo advisor, not all your goals are taken into consideration. For example, a robo advisor will not know if you are looking to buy a house or saving for your children’s college tuition. In addition to this, robo finance does not take into account any money-related problems and will not give you any compassion after a dramatic market drop.

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What Is a Robo Advisor Offering?

It is a common misconception that all robo advisors are the same; there are many options when it comes to choosing your robo advisor. You should ask yourself certain questions when choosing your robo finance service. These include:

What is your end goal?
What do you want your minimum deposit to be?
What annual fees are you willing to pay with a robo advisor?
Where do you want to allocate your assets?
Do you want an automated or a robo advisor service?
Do you want tax optimization as part of your robo advisor service?
Do you want to manage your funds, or do you want the robo advisor firm to manage them directly?
Do you need all your assets managed by a robo advisor or just a portion?

Cost is an important part when choosing your robo advisor service. It is important to note that the price quoted by robo advisors is only for their fees; it does not include the ETF fees.

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What Is a Robo Advisor? – Conclusion

With the adoption rate of robo advisors predicted to grow from 0.5% in 2015 to 5.6% by 2020 (according to ATKearney), there are very good reasons to consider robo finance services. Robo advisor services continue to open the financial advisory market to young people, thanks to low fees and ease of access, among other reasons.

Making the right decision with your investment is crucial. It is therefore extremely important to research the range of robo advisors available. Aside from the low fees, it is important to consider your personal financial situation and choose the robo advisor that best suits these.

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